Shadow banking outside banks

Ever since the banking crisis overwhelmed the financial world in 2008, obtaining bank loans for any purpose has been a daunting task in any corner of the world. Bankers have become hypersensitive about their reputations regarding loose and predatory lending practices and are afraid of heavy sanctions and punitive fines. Having conventional bank loans for most small- to medium-sized businesses in a developing country like Bangladesh is more intimidating. The process is time-consuming and labour-intensive and the paperwork is burdensome. Moreover, the invasive underwriting procedures that are needed to apply for a bank loan, require reams of documentation, tough scrutiny, and nitpicky verifications. Traditional lending from banks has been further impeded by ever-renewing banking legislations passed by the governments and ever-increasing oversight and newer regulations executed by the central or federal banks.
Huge amounts of money -- black or white - are said to be in private hands in Bangladesh. These private hands frantically scurry for cover, allegedly stashing away their treasures in overseas havens or behind unproductive assets, such as lands, jewels, or metals. Alternative lenders who can have access to this vast amount of private money can expand resources for businesses needing reliable loans without the hassles and restrictions they face in a bank.
BANKS VERSUS ALTERNATIVE LENDERS: By 'alternative lenders', it is not, of course, meant those loan sharks, like 'Kabuliwalas', who offer loans at extremely high lending rates or those swindlers, like Ponzi scheme operators, who pay big returns to one investor from new capital paid to the swindler by another investor, only to flee away at the end of the day. Neither is it meant that firms like 'mom-and-pop shops' whose only capital is their maternal uncle having links with the powerhouse or entrusting a wolf to watch a henhouse. By an 'alternative lender' it is meant a solid body with proven track-record like insurance companies, leasing companies, pension funds and other non-banking institutions in Bangladesh like, for instance, cell phone operators, reputed non-governmental organisations (NGOs), or investment companies. Think of Grameen Bank, that started its maiden journey as an NGO.
Such alternative lenders must hold enough liquid assets, to guard against runs; limits on their leverage have to be imposed by the controlling authorities. How the alternative lenders should be allowed to behave is the central bank's cup of tea. Bangladesh Bank (BB) knows it better what vehicles should be incorporated in the lender's balance-sheets to stop it from making shams.
Only banks can hold deposits mostly guaranteed by the state, and only banks are conventionally authorised by the central bank to offer credits. This is a privilege, of course governed by lots of rules and restrictions, that only banks have traditionally enjoyed. But banks are sometimes 'white elephants' as is found in many state-owned banks where employees do not run the risk of being fired for their non-performing loans (NPLs). And banks are vulnerable to runs. Unbridled banks spark global financial crises. Banks are no more user-friendly as they once used to be.
Banks lack leverage -- the amount a bank borrows relative to the amount of loss-absorbing equity it has. A worry that plagues a bank most is a maturity mismatch: disparity between the time scales of a financial institution's borrowing and lending. Save and except for the state-owned banks which sleep on long-term idle government funds, most banks in Bangladesh and elsewhere, have short-term deposits while they have to issue long-term loans. Correcting this mismatch by holding more long-term deposits on the part of a private bank in Bangladesh is pretty strenuous when the government offers to public high rates of returns against their long-term savings schemes and those private hands that hold huge secret funds are squeamish about the watchdogs of taxation and money-laundering.
Worldwide, banks are no more as they used to be. Some banks unfortunately have turned from lending institutions into laundering institutions. Some regulated banks have become inherently unsafe.
Beset by heavier regulations, higher capital requirements, endless legal troubles and colossal fines, the genuine banks, with pristine reputations, are retrenching, cutting their lending and shutting many of their outlets. The British banks have slashed their loans to businesses by almost 30 per cent since 2007, with Barclays just two weeks back confirming plans to shed up to 14,000 staff. With banks finding their latitude in offering credit and other ancillary services shrinking, individuals, institutions and shadow banks, armed with hefty funds, are springing up to fill the gap.
A NEW TREND OF BANKING BUSINESSES: The financial world is nowadays abuzz with a new trend of banking businesses that are shifting from conventional banks to alternative sources, the sources that in the western world are known as hubs of 'shadow banking'. The US Financial Stability Board (FSB), an international watchdog, defines shadow banking as "credit intermediation involving entities and activities outside the regular banking system". Lending by anything other than a bank, in other words, is shadow banking.
Money from savers can nowadays move directly to borrowers through channels that do not involve banks. People have traditionally made loans to one another directly. A company in America can now borrow money from savers pooled by the bond markets, not from a bank.
Non-banking institutions dealing in shadow banking are huge and fast-growing, taking away a significant chunk of global market share from the mainstream banks. Shadow banking, as reckoned by FSB, accounts for a quarter of the global financial system, with assets of $71 trillion at the beginning of last year, up from $26 trillion a decade earlier. In some countries, shadow banks are expanding even faster: in China, for instance, they grew by 42 per cent in 2012 alone.
Promising signs of non-banking financial institutions making a good dent into the Bangladesh economy are already visible. These non-banking institutions in the last nine months (July-March), as reported in the media, have lent Taka 54.65 billion (USD 683.13 million) in the industrial sector. The disbursement rate is 24.14 per cent more compared to the same period in the previous year. The total loan outstanding of such non-banking institutions during the same period stands at Taka 149 billion (USD 1.86) while the figure during the same period of the previous year was Taka 125.05 (USD 1.56 billion), marking an increase of 12.31 per cent.
Compared to banks, the clients find it easier to avail themselves of loans from these non-banking institutions, which constitute some leasing companies, insurance companies and the likes of cooperative bodies. The loans are mostly of short-term character to cater to working capital needs of various industries. Contribution of non-banking institutions in commercial finance is still small compared to that of mainstream banks. There is, of course, a promising future awaiting those entrepreneurs who will open their shops for shadow banking.
Bangladesh is not lagging far behind in expanding the banking business outside the banks by providing limited-scale banking and financial services to the under-served population. Authorised agents may now conduct banking transactions on behalf of a bank, as is stipulated in the guidelines on "Agent Banking for Banks", framed by the Bangladesh Bank. But utmost care must be taken so that an unscrupulous agent does not get a scope to enter the bank 'as a thin needle and then exit as a fat awl', as goes the Bengali proverb, only to fleece the bank and its customers.
THE SEVEREST BLOW: However, the severest blow the brick-and-mortar banks all over the world have suffered is from those who are robbing them of their payment business. Payment business brought to banks USD 1.3 trillion or 34 per cent of their global profits, according to McKinsey. This business is fast moving to titans like PayPal in the shadow banking and giants like Google in the Internet world. Banks are heading for a bleak future as people have already started storing their money outside the banking sector and making payments that are not tied to a formal bank account. The threat to banks from such novel payments systems is pretty clear in poor and developing countries like Bangladesh, since a smaller share of their populations is maintaining bank accounts.
PayPal, basically an online-payments service, is making "depositing money in a bank and withdrawing it when necessary" just redundant. Besides paying online, a PayPal account holder does not need to carry those plastic cards. As you come to the cashier with your trolley loaded with your purchases you simply enter your phone number and a personal code on the panel of the magnetic stripe reader, and electronic magic takes care of the rest. If you have a smart phone with the PayPal's app installed, just hold up a barcode for the cashier to scan and the job is done. More bizarre is the service offered by a firm called "Square". You don't need to say, show or touch anything; just keep your smart phone inside your pocket. As you enter a store your phone from inside your pocket does everything. The phone installed with the Square app informs the store that you have entered and as you are leaving the store with merchandise the cashier gets what she needs wirelessly from your phone: your picture, signature, PIN number, etc. The cashier, without uttering a single word, simply looks at your face just to make sure you are who you claim to be.
PayPal has 143 million active accounts and handled $180 billion in payments last year. In Africa, a mobile-phone payment service called M-PESA has been so popular that the company is venturing into Asia and Europe. Google offers a virtual wallet and Amazon has already set up a service to allow its customers to transfer money.
The powerful players in shadow banking or the titans in the cloud constitute a vital tool for good financing but, if carelessly managed, it may explode causing a devastating financial crisis.
The writer started his banking career in Agrani Bank and retired as a General Manager of Bangladesh Krishi Bank. He can be reached at maswood@hotmail.com